Bank Loans Are Beating Bonds

In a forgettable quarter for bonds, leveraged loans emerged as the star income asset class.

What made leveraged loans a fixed-income standout is that they're not really fixed income at all. They consist of bank loans made to companies with speculative-grade ratings, and they offer floating interest rates that are tied to the London interbank offered rate. While fixed-rate bonds could suffer losses when prevailing interest rates rise, loans offer a welcome hedge.

But rates haven't risen meaningfully yet. Instead, investors are loading up on loans ahead of an expected long-term rise, and in the meantime they're earning a 5.1% average yield, pretty compelling these days even in a neutral rate environment.

The 2.11% quarterly return for loans still trailed the 2.85% tally for their kindred asset class, non-investment grade (junk) bonds. But the average junk bond, which yields just 5.62%, now trades at 105.3 cents on the dollar.

Bob Worthington, president of Hatteras Funds, which has increased its loan holdings recently, says, "The market for bank loans is giving you the same type of yield [as junk bonds], but they're higher in the capital structure, and you're better protected in case something happens to the company." He notes that credit quality is similar at a time when the default rate remains below average.

Source:  Michael Aneiro, Barron's

PowerShares Senior Loan Portfolio (BKLN) is a component of the D2 Capital Management Multi-Asset Income Portfolio and Eaton Vance Floating Rate (EABLX) is a component of many of our  mutual fund portfolios.

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